Many analysts attribute these imbalances to low interest rates, supported by an undervalued exchange rate, which they perceive as having repressed consumption and encouraged excessive investment.

Yet the primary reason for China’s imbalances is not financial repression but a broadly successful urbanisation–industrialisation process. This process has caused household income to fall as a share of GDP and the savings rate to rise, which together explain the decline in consumption as a share of GDP over the past decade and half.

To understand why this is the case, assume for instance that a typical Chinese farmer produces rice worth RMB10,000 a year and nets 9000 after paying for inputs. He then saves 2000 and spends 7000. In the national accounts, his activity translates into a consumption share of 70 per cent of the value of production. Suppose that he moves to Shenzhen and gets a job with Foxconn and is paid a typical RMB30,000 a year. Like most migrants, he saves half and consumes half, or 15,000. Foxconn combines his labour with capital and imported parts to produce iPads worth 60,000 in terms of valued added. His consumption as a share of industrial value added is now 25 per cent.

This particular labour transfer shows up in the national accounts as labour’s share of output going from 90 to 50 per cent and consumption as a share of GDP going from 70 to 25 per cent. The same story has been replicated through the transfer of tens of millions of migrant workers annually, which has led to a sharp decline in workers in agriculture from around 50 to 35 per cent of the labour force, and a commensurate increase in industry and services that has seen labour’s share of GDP plunge by 7 percentage points over the past decade. There is nothing perverse about this fall. Migrant workers are earning and consuming multiples more than they used to, firms are able to expand through increased labour absorption and investments, and the country benefits from higher productivity and double-digit growth rates.

The impact of the urbanisation–industrialisation process becomes even clearer when the decline in household income as a share of GDP is examined by region. If financial repression or exchange rates are the reasons behind China’s unbalanced growth, one would expect any decline to be more pronounced in the east, where the majority of industrial and commercial centres are located.

In fact, the opposite is true. Since 2000, it has been the far west, not the east coast, that has experienced a huge 40 per cent decline in the share of household income to GDP, while other regions have undergone a far more gradual decline of a few percentage points annually over several decades.

The urbanisation–industrialisation process is behind this sharp descent in the west. The region’s delayed urbanisation process relative to the rest of the country explains its high household income share prior to 2000. And Beijing’s ‘Develop the West’ initiative, launched in the late 1990s, supported massive investments in infrastructure and income generating activities. This prompted a rapid decline in labour’s share of production as workers shifted from traditional rural activities to industry and services with much higher earnings potential.

The decline in consumption as a share of GDP has also been amplified by higher savings rates, which is again partially attributable to urbanisation through labour migration. The increase in overall savings rates is entirely due to escalating urban savings rates since rural savings rates have remained broadly unchanged. This regional differentiation comes from migrant workers being ineligible to access social services in cities due to lack of residency rights, which then forces them to save a much higher proportion of their income over established urban residents.

China’s unbalanced growth pattern also mirrors that of other successful emerging East Asian economies. The consumption share of GDP for Japan, South Korea and Taiwan fell by 20–30 percentage points as their economies transitioned, bottoming out at adjusted per capita income levels in the range of US$12–15,000, compared with China’s current $9,000. The decline in the consumption share is mirrored by a sustained increase in the investment share of GDP in all three economies, peaking around 40 per cent of GDP. The common thread linking all these countries is that widening imbalances were similarly associated with the urbanisation and high-growth rates that allowed them to escape the middle-income trap and eventually transition to more balanced outcomes as their economies matured.

In sum, urbanisation is largely behind the decline in consumption as a share of GDP. Misinterpreting the reasons why China’s growth is unbalanced in terms of macro-aggregates leads to the wrong policy prescriptions, including the argument that China needs a more ‘consumption-led’ growth model (a concept that does not exist in economic theory) or that China needs to grow more slowly so that the share of consumption to GDP will increase — a line of reasoning which confuses means and ends.

But China does face major economic problems brought on by declining productivity and surging debt levels. The challenge for the new leadership is to escape the middle-income trap by implementing a complex set of structural reforms that would allow the economy to grow at around 7 per cent for the remainder of this decade. This will not be easy. China needs to improve the efficiency of its urbanisation process and develop more appropriate financing sources. If it succeeds, then rebalancing will eventually occur as a by-product of a more sustainable growth path, rather than as the ultimate objective.

Yukon Huang is a Senior Associate at the Carnegie Endowment and a former World Bank country director for China.

A version of this article with explanatory diagrams and graphs was originally published in the Financial Times, and can also be accessed here.